WealthManagementTrainingIntroductiontoRealEstateInvestments

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Table of Contents

I. Introduction to Investments – Broad Classifications

II. Real Estate Investment Opportunities

III. Cytonn’s Strategy

IV. Overview of Real Estate Market in Kenya

V. Legal Factors to Consider in Real Estate Investments

VI. Conclusion

33

I: Introduction to Investments

44

Macro Economic Variables Determine investmentsKnowing what investments will do well under each scenario is important

• Investments: This is the purchase of an Asset with the hope of generating some income in future or the asset

appreciating hence being able to sell it at a profit

• The investment outlook of an economy is determined by :

Ø Expected GDP or economic growth globally and locally

Ø Level of inflation and interest rates

Ø The currency prospects

Ø Performance of other trading countries

Ø Political stability

Ø Social stability

The performance of the investments is largely determined by peoples views on all the above

55

Introduction to Investments – Broad ClassificationsThere are two main broad classifications of investments based on the ease of accessibility

• Liquid• Price visible on stock exchange

Traditional Investments

Alternative Investments

Description Characteristics

i. Equities

ii. Fixed Income• Liquid• Highly sensitive to interest rates• Returns made of both coupon and principal

i. Private Equity

ii. Real Estate• Illiquid• Provides inflation hedge (have their own value)• Low correlation with traditional investments• Lack of availability of transaction data

• Illiquid• Difficult to price• Lack of availability of transaction data

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II: Real Estate Investment Opportunities

77Source:AlexanderForbes

Forms of Real Estate• Investments into real estate can be categorized into public and private market investments:

Private Public

• Ownership usually involves direct investments likepurchasing property or lending money to a purchaser

• Direct investments can be solely owned or indirectlyowned through partnerships or commingled realestate funds

• Ownership involves securities that serve as claims onthe underlying asset

• Includes ownership in a real estate investment trust(REIT), a real estate operating company (REOP)

Introduction to Real EstatePrivate and public real estate have distinct characteristics

88

Residential Non-residential

• Single-family homes

• Multi-family properties

• Offices

• Industrial/warehouse developments

• Retail

• Hospitality

• Mixed-use developments

Real Estate

Classification of Real EstateA simplified classification of real estate assets; the examples listed are not exhaustive

99

Kenya’s GDP Growth Avg. 6% since 2010, needs financing

• 2016 GDP is expected to come in at 6.0% underpinned by (i) high government expenditure on infrastructure, (ii) the

energy sector growing at 6.8%, (iii) Real Estate estimated to grow at 6.9%, (iv) Agriculture growing at 3.4% and(iv) the recovery of tourism growing at 9.5%

Source – Cytonn Research

8.4%

6.1%

4.6%

5.7%5.3% 5.6% 6.0%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

2010 2011 2012 2013 2014 2015 2016e

GDPGrowth

1010

Real Estate Contribution to GDP Has Been IncreasingReal Estate is among the fastest growing sectors in the economy, contributing to 8.2% of GDP, from 4.8% in 2010

• The Real Estate sector is among the fastest growing sectors in the economy driven by a fast growing middle class and

improved infrastructural developments by the government• Despite Agriculture being the main driver of the economy, the tide is shifting and sectors such as Real Estate are

emerging as the fastest growing sectors and are positioned well enough to drive the economy in the years to come.

Real Estate is now the 5th highest contributor to Kenya’s GDP, having a 5 yr. growth rate of 5.0%• In order for this growth to be sustainable, access to credit is vital and PE investments are a major source in providing

an alternative solution other than the traditional sources

Source – KNBS

4.8%

8.1% 8.0% 7.9% 7.8% 8.2%

0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%

2010 2011 2012 2013 2014 2015

RealEstate

Contribution(%)

1111

Returns: Real Estate Offers the Highest Returns – Creating WealthTraditional investments returning 10% compared to 25% for real estate, & projected to continue

Per a

nnum

Ret

urn,

5 Y

ear A

vera

ge

25%

12.3%

10% 9.6%

0%

5%

10%

15%

20%

25%

30%

RealEstate 10YearTreasuryBondYield NASI 91DayT-Bill

Average =14.2%

1212

And the Best Returns are Not in the Listed Markets …Yet..The opportunity to securitize real estate will increase deepening of the capital markets in Kenya

• The investments in alternative markets can be packaged into securities that enable the public (those who are unable to

invest in such asset classes) an opportunity to own real estate, and lead to deepening of our capital markets

• REIT’s such as FRED and Fahari I-Reit are examples of such securities and have increased the market cap of the

securities exchange and capital markets deepening

6.85%

5.92%

2.56%

0.06%0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

SouthAfrica USA UK Kenya

REITMarketCap.ToGDP

TargetArea

1313

Portfolio Allocation and Returns – Case of 2015Portfolios with allocation to alternatives outperformed those without alternative investment exposure

• We consider a typical conservative moderate portfolio with 65:35 allocation in fixed income and equities, (all traditional

investment portfolio) and another with 50:30:20 allocation in fixed income, equities and Real estate (alternative

investment)

• As indicated below, taking 2015 as a case, a portfolio with purely traditional investments recorded a negative return of

6.0% compared to a positive return of 0.7% in a portfolio with exposure in alternatives

Portfolio

AssetClasses 2015AssetClassReturn WithoutAlternatives WithAlternatives

FixedIncome (3.5%) 65.0% 50.0%

ListedEquities (10.6%) 35.0% 30.0%

RealEstate 25.0% 0.0% 20.0%

WeightedReturn (6.0%) 0.7%

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III. Cytonn’s Strategy

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Cytonn’s strategy Cytonn looks to bridge the Supply and Demand gap in the Real Estate market

2011

2012

2013

• For many years, the supply and demand have been largely disconnected in the Kenyan Real Estate market, characterized

by adhoc forays by players on both sides

DEVELOPERSINSTITUTIONAL

& HIGH-NET WORTH

Demand SideSupply Side / Developers

Cytonn & PEPlayers

PE Players to Couple Supply & Demand

By matching demand in the economy, which is 200,000 units per annum, to supply from institutional grade real estate

developers in the region, private equity players provide expertise and execution capability to reduce the housing

deficit in Kenya

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Citizens spending more on Rent & Utilities

2011

Demographic Trends: Share of the Wallet

Source: Research by Ark Africa, 2014

60% 5%

• Individuals are willing to spend up to 60% of their Income on Rent & Utilities

• This growing wallet share, combined with rapid urbanization bodes well for Real Estate

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2011

The Opportunity in Residential HousingReal Estate has the opportunity to create Kshs 240 Bn of AUM

• 14 Million Kenyans are employed35% of the 40 MillionKenyans are employed

Of the 14 Million employed, 20% earn on Average KES

100K

The 1.4 Million people are able to spend KES 20,000

per Month on rent

These Cash-flowscan create an AUM of KES

241 Billion

• 3.5 Million Kenyans earn KES 100,000 per month• 75% of those reside in the Nairobi area & Metropolis

• 67% of residents within Nairobi Metropolis are renters

• 1.4 Mn X 20,000 = Cash Flows of KES 28.1 Billion per month• This equates to KES 337 Billion per Annum

• Assuming we Target only 5%, it equates to roughly KES 16.9 Billion perannum

• Capitalization for the KES 16.9 Billion is at 7%

• This equals to KES 241 Billion of AUM

TheopportunityinRealEstateissimilartothatwhichEquityhadinBanking,andSafaricominTelecommunications10Yearsago

1818

Key Themes Driving our Property DevelopmentThe below are just a few of the factors driving our thematic investments in Real Estate

KEY THEME REAL ESTATE SECTOR PROVIDING EXPOSURE TO KEY THEME

Master Planned Communities

CommercialOffice Parks

CommercialMixed-Use

Suburban Malls

HospitalitySector

1. Large Housing Deficit P P

2. Growth of Middle Class P P P P P

3. Demographic Trends P P P P P

4. Improved Infrastructure P P P P P

5. Political Decentralization P P P P P

6. Kenya as a Regional Hub P P P P P

1919

VI. Overview of Real Estate Market in Kenya

2020

Real Estate in KenyaReal estate sector expected to continue growing on the back of developments such as REIT’s, and the entry of institutionaldevelopers and financiers to the market

Macro-economic Contribution

• The real estate sector contributed to 8.2% of Kenya’s GDP in Q1 2016• In Q3/2015, the construction and real estate industry recorded the highest growth at 14.1%,

compared to 10.1% in financial services and 7.1% growth in agriculture• A stable political environment, as well as favourable macroeconomic conditions such as a

relatively stable interest rate environment have led to positive development in the sector

• Real estate has consistently out performed other asset classes in the last 5 years, generatingreturns of 25% p.a., compared to an average of 10% p,a. in the traditional asset classes

• Residential units in Kenya generate an average rental yield of 5.0%, while commercial spacegenerates an average yield of over 9.0%

High Returns

Recent Developments

Market Outlook

• The real estate sector which was previously dominated by individual developers has seen entryof more institutional developers such as Saccos, private equity firms and foreign institutions

• Development of REITS in the capital markets, as a way to raise funding and exit real estatedevelopments, is likely to attract more institutional investors

• The real estate market has also seen an increased interest in the structured products aimed ateasing the financing of the developments in the market

• We expect continued growth on the back of improved macroeconomic conditions, sustainable highreturns, and a changing operational landscape as developers strive to satisfy the high housingdeficit

• The industry however continues face challenges such as the unfavourable interest rateenvironment

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Factors to Consider when Investing in Real EstateMarket performance is the key factor to consider while investing in real estate as it helps determine expected returns• Real estate investment involves a relatively favourable risk/reward profile, but with relatively low liquidity as compared to

other types of investments

• When considering investing into real estate, one should put into consideration the following factors;

• Market performance – One should analyse on the real estate trends over a given period, e.g. five years to measure the

expected future returns on the investment based on the following factors:

• Uptake – Find the historical and current records of the market uptakes, as this is directly related to the futureexpected gains in terms of price appreciation and demand hence a better cash conversion period for the projects

• Occupancy – This informs on the market performance, in terms of expected rental yields and rental escalations

• Rental yields – Rental yield is a key factor to long term project profitability as its related to the time needed torecover your initial investment. Thus a market or real estate theme with a higher rental yield is more attractive.

For example its more profitable to invest in commercial office at 10% rental yields as compared to residential at6% rental yield in Nairobi market, all other factors held constant

• Capital Appreciation – This informs mainly on land investment. It helps investors make a decision based on

whether to buy land for speculations and developers too can consider land banking for future gains

2222

Location is a key factor to profitability in real estate as it is directly related to property valuations

• Location – This is the key factor to profitability in real estate as it is directly related to property valuations. Proximity to

amenities, neighbourhood status and scenic views are major factors for residential property valuations; while proximityto markets, warehouses, transport hubs, freeways, tax-exempt areas, play an important role for commercial property

valuations

• Infrastructure – Investors should consider factors such as road network, sewer line , electricity and water connections

among others in the area to enable accessibility and for convenience as they directly increases the value of the project aswell as demand

• Security – Security in the area is directly affects the uptake of the projects as clients have more confidence for areasassociated with safety

• Supply and Competition – This are key factors to consider whether the type of investment you want to venture into

has been exhausted by other developers and the type of the competitors you expect into the industry. This will helpprevent you from being locked in a project

Factors to Consider when Investing in Real Estate, continued…

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Real Estate ExposureDespite being capital intensive, there are several ways how one can get exposure in real estate• Real Estate is capital intensive and therefore, not everyone can get into this kind of investment. However, there are

several ways through which one can invest in Real Estate namely

• Real Estate Investment Trusts (REIT’s) - A REIT is a company that mainly owns and operates incomeproducing real estate such as apartments, shopping centers, offices, hotels and warehouses. REITs were createdin order to make investments in large scale income producing real estate available to average investors. Thereare 2 kinds of REITS,

• Investment REIT (I-REIT) – This is an investment in an income generating Real Estate such asresidential or retail developments where 90% of the income is distributed among the REIT holders asdividends. In Kenya, The Fahari I- REIT is the first of its kind having achieved only 29% subscription atissue

• Development REIT (D-REIT) – This is an investment in an development company where the REITHolders will receive their returns once the company exits the development. In Kenya Fusion D-Reit wouldhave been the first of its kind but however failed to get the minimum requirements in terms ofsubscriptions and number of individual investor

• Project Notes – This is a structured debt instrument backed by a Real Estate project where investors buy intothe note which guarantees them a return. The notes can be structured in a way that the minimum amountinvestable is favorable for people with fewer funds at their disposal

• Shares in a Real Estate company – A Real Estate company, either a developer or an investing company, canlist on the main bourse allowing common investors to have a chance to tap into the high returns from RealEstate. As the company derives value for Real Estate, so will the investors realize value through share priceappreciation and dividend payments

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Real Estate Investments – Traditional WayTraditionally Kenyans have been investing in real estate via Brick and Mortar • There are two ways to access real estate in any market,

o Brick and mortar: this is the development of a building or the purchase of a parcel of land, aiming to benefitfrom future capital appreciation and rental income

o Real estate investments: this is the conversion of the physical real estate asset into a liquid investable

product. This can either be public markets tradable like REITs or privately placed• Traditionally, Kenyan’s have been investing through the brick and mortar way. However they have been facing the

following challenges:

Source: Cytonn Research

HowWeHaveTraditionally

Invested inRealEstate

Summary

• Traditionally, Kenyans used to invest in real estate through brick and Mortar. They would purchase a piece of land and then embark on developing a building

• Financing for these investments istypically personal savings and expensive bank debt

Challenges• The traditional way of investing in Real

Estate had the following challenges;1. Illiquidity – Exiting brick and

mortar Real Estate is hard as there lacks an official platform for transactions and pricing is opaque

2. Delays in land titling process3. Brick and mortar Real Estate is

expensive hence people resort to expensive bank debt

2525

Real Estate Investments – The “Sharp” WayThere are three broad ways through which one can invest in real estate

• Apart from the traditional ‘smart’ way of investing in Real Estate which was through brick and mortar, investors can opt

for the following ‘sharp’ investment options, depending on the investors’ investment needs, risk/return profile, timehorizon and liquidity needs;

Source: Cytonn Research

InvestmentType

Description InvestmentHorizon

RiskAppetite/ReturnProfile

EquityPurchasingpartialownershipofavehicleowningrealestatedevelopmentsandusingaprofessionaldevelopertomanagethedevelopmentactivities

3-7Yrs Riskappetiteishighhencetheydemandreturnsinexcessof25.0%

Mezzanine

Providingsubordinatedfinancingtoarealestatedevelopment.Thefinancingisjuniortobankdebt,hencegetspaidonlyafterthebankbutseniortoequity,hencegetspaidbeforeequityinvestors

1-3Yrs Riskappetiteismoderatehencedemandreturnsofbetween14-15%

Project Notes Thisinvolvesfinancingforconstructionbyinvestinginafixedincomenotebackedbyrealestate

1Yr(Dependsonsetmilestones)

Riskappetiteislow,howevertheydemandreturnsonaverageof18.0%duetotheleveragetheyhold.Theyusuallyfinance60.0%oftheproject

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Investment Planning Process for Private Real Estate Projects

For private players, planning for an investment in a real estate project requires many steps; spanning from market

research and feasibility tests/modelling, budgeting and project finance/fundraising, project management and eventually

exit;

I. Market Research – Involved in proactive and reactive research activities mainly aimed at informing the

strategy for deal origination or project feasibility;

II. Project Finance – Involved in raising of capital to run the project and financial modelling for the project to test

financial viability and budget formulation;

III. Project management – Involved in running of the project, ensuring budgets and timelines are adhered to;

IV. Exit – Involves the realization of the investment return.

2727

ResearchIdea

ResearchDesign PresentationData

Collection

DataAnalysisAnd

Publication

• Proactive and reactive research

• Hypothesis to be guided by leads under evaluation and focus of the week

• Specifying type of data to be collected(qualitative, quantitative or both)

• Construction of questionnaire• Preparation of data entry, analysis and

presentation template• Determination of sampling process

and sample size

• Desktop research and field survey

• Data cleaning and record

• Statistical evaluations• Hypothesis testing

• Comments and recommendations are made

• Verdict to be given on whether to proceed

Market Research needs to be both proactive and reactive

2828

After Market Research, Budgeting and Project Financing begins Fundraising for real estate is key considering the capital intensive nature of projects

• The capital intensive nature of real estate projects is quite daunting for anyone looking to develop or invest in real

estate. It is therefore imperative for one to have a strategy for accumulating the funds to embark on a project of thisnature

• For this reason, fundraising for real estate is one of the most important aspects in the development process

• There is an abundance of capital in the market. However, what is lacking is knowledge of how to tap into these sourcesof capital and to channel these funds into real estate developments. Strategic ways that any company can tap into this

include:• Institutionalize development: Have proper corporate governance structures to build investors confidence in

your company and products

• Structuring real estate into investment instruments that are focused on target returns: Investors aremore interested in returns rather than the brick and mortar aspect. Packaging your product into an investment is

thus important• Coupling fundraising and development: Given the very risky nature of development, investors tend to want

the fundraising function working alongside the development function in order to ensure that the development

process is very sensitive and responsive to return expectations• Professionalized development: Employing professional development and project management experts, and

having strong investment committees approve development prior to commencement

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Typical Capital Structure & Value ChainHighlighted is our typical Real Estate capital structure consisting of 60% debt and 40% equity

Real Estate DevelopmentReal Estate Finance Real Estate Investments

60%

20%

20%

MezzanineFinancing fromMezz. Fund

DebtFundingfromBanks

Partnership Units (LLP)

REIT’s Fund

Other Income Funds

EquityfromLandOwner orCashfromProperty Fund

MezzaninefromMezzanineFund

3030

V. Legal Factors to Consider in Real Estate Investments

3131

I have made a decision to invest in Real Estate so what next…

• Investment in Real Estate involves dealing in land and as we all know, in Kenya and generally the whole of Africa, themost emotional and complex issues legal issues revolve around land with some land matters stuck in court for 20 years or

more, something that warranted a specialised Court for Land matters at the level of the High Court, the Land andEnvironmental Division;

• Real Estate Companies such as Cytonn Real Estate, LLP through its structured projects or real estate units provide aneasy and convenient way to invest in real estate as they put into consideration the key legal matters that need to beconsidered in a Real Estate investment, throughout the project life cycle, which include:-

• Undertaking Due Diligence prior to acquisition;

• Tax Structuring and choosing the right legal entity;

• Ensuring the relevant statutory approvals are obtained to facilitate the construction and the contract documents

with the various contractors and professionals are legally sound;

• Preparing the right legal documentation to facilitate the sales process such as Sale Agreements and Leases; and

• Determining the right structure and preparing the relevant legal documentation for Management of the Property

after completion of the Project.

Legal Factors to Consider in Real Estate

3232

VI. Conclusion

3333

ConclusionReal Estate has delivered the best returns over the past years with a 5-year average of 25.0%

• Real Estate and Construction industry’s contribution to GDP has bee on the rise since 2000 from 10.5% to 13.8% in

Q2’2016. It has also been the consistent asset class in terms of performance delivering a 5-year average return of 25.0%

• With continued government expenditure in improving infrastructure and energy provision, the sector is expected to

continue to grow. With this positive outlook, it is imperative that fund managers should have an exposure to Real Estate

to achieve high and stable returns in future

10.5%

8.3%

11.7%12.6%

13.8%

0.0%2.0%4.0%6.0%8.0%10.0%12.0%14.0%16.0%

2000 2005 2010 2015 Q2'2016

RealEstateandConstructionContributiontoGDP

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Q&A